The Bad News Gets Worse

Business tumbles, the political fallout hits and tax cut talk begins

Some economists call it a free fall. To the 1.7 million people added to the jobless rolls in April and May, the U.S. economy may well seem to have toppled off a cliff or been sucked into a black hole. Whatever the metaphor, the numbers that came out last week left no doubt: not only has the long-feared recession begun but it is already shaping up as one of the worst slumps since the Great Depression of the 1930s.

The key figures:

> Unemployment in May jumped to 7.8% of the work force, from 7% in April and 6.2% in March, the steepest two-month rise in at least 32 years. The rate already is well above the 7.2% figure that the Carter Administration had forecast for the end of the year. Each week 675,000 laid-off workers are filing claims for unemployment compensation.

> Sales of U.S.-made cars in May tumbled 37% below a year earlier, to less than 500,000. In fact, the average selling rate on each day that the showrooms were open was the lowest for any May since 1963. In this quarter, auto plants will build fewer cars than in any second quarter since 1961.

> New orders received by U.S. factories in April fell 5.5% from the month before, the sharpest drop in more than five years. In April the factories operated at only 81% of capacity, down from 84.4% in January.

> Spending for new construction in April fell 3.6% from March, which had been down 5.4% from February, the sharpest fall in at least five years. The figures indicate that commercial and industrial construction have gone into a nosedive along with housing. Housing starts in April ran at an annual rate just above 1 million, close to the lows of the 1973-75 recession. The U.S. League of Savings Associations predicts that housing starts for the whole year will total only 1,050,000. That would be the smallest number since 1946.

> Interest rates continued to slide almost as rapidly as they went up last winter and early spring. Major banks reduced their prime rate on business loans to 13%, far below the unheard-of peak of 20% reached in April. Fundamentally, that is a note of cheer: the decline will make it easier for consumers to finance purchases of houses and cars and for businesses to build new plants. But not much easier: the rates are still higher than any reached before 1979. And the speed and depth of the drop shows how abruptly the high rates choked off the business and consumer borrowing that had kept the economy growing.

What makes the virulence of the slump most remarkable is that it happened so fast. To be sure, the housing and auto industries turned down sharply last year. But only weeks ago there were still no conclusive signs that the weakness had spread to the rest of the economy. In the steel industry, for example, buying by nonauto customers kept sales and production fairly high until March. Says Donald Barnett, chief economist of the American Iron and Steel Institute: "Orders dropped 40% within a week."

In fact, it was only last week that the slump got its official credentials from the National Bureau of Economic Research, the private Cambridge-based organization that establishes the starting and ending dates of recessions. At a special meeting, its Business Cycle Dating Committee decided that the evidence is unmistakable: the U.S. is indeed in a recession. The economy reached its high point in January and has gone downhill ever since.

How bad that damage may get, and how long it will last, is anybody's guess. TIME's Board of Economists last week rendered a mixed verdict: the downturn will proceed at least through the rest of this year, and on the whole will not be quite as violent as the one in 1973-75, though it may be worse in some specific respects--notably unemployment (see following story).

There is no doubt that the recession will greatly magnify the political problems of Jimmy Carter. While no one would ever admit it publicly, his policies seemed designed to produce a recession deliberately. He hoped that it would be short and mild, but apparently accepted the widespread opinion that only a recession could break the U.S. inflation.

That policy already has got Carter in trouble in his own party; anger about inflation and recession helped to propel Ted Kennedy to his victories in last week's primaries. Says one seasoned Washington observer: "The very people Carter needs most, blue-collar people in the industrial states, are going to be the people worst hurt." Republicans agree, even though the Carter policies in question are the standard G.O.P. nostrums of curbing Government spending and encouraging the Federal Reserve to follow a tight-money policy. Says Republican National Committee Chairman William Brock: "Carter is consciously using human beings as cannon fodder in his war against inflation. We're going to take his hide off on that."

Actually, of course, the President neither expected nor wanted a recession as severe as the one that has begun. The most serious charge against him--and it is a grievous one--is that he failed to take sufficiently vigorous action against inflation until it soared past 18%. Once inflation had gone that far, a deep recession became inevitable: consumers simply had to cut back their buying of goods and services because prices were rising so much faster than incomes.

Now that the slump has begun, it poses a severe dilemma for Government policy: How far can recession-fighting measures go before they worsen the inflation that helped bring on the recession in the first place? Speaking to bankers in New Orleans last week, Treasury Secretary G. William Miller asserted that the Administration has "got to stay with fighting inflation as the No. 1 priority." Paul Volcker, chairman of the Federal Reserve Board, has indicated no relaxation of the board's tight squeeze on money supply. But the nation's central bank already has begun to dismantle the restrictions on consumer credit that it put on last March.

Administration officials now concede that they may have dealt too great a psychological shock to consumers by encouraging the Federal Reserve to clamp controls on credit buying, and businessmen agree. Says James L. Harris, President of the Washington Federal Savings and Loan Association: "People thought using their credit cards was not only illegal, but against the church."

Miller nonetheless opposes a Senate move to repeal the President's authority to ask the Reserve Board to impose credit controls, on the ground that controls could still be needed in an inflationary emergency. Congress itself is all but hopelessly hung up in a battle about how much to increase military spending, and how far to cut social services, in the budget for fiscal 1981, which starts Oct. 1. Congress and Carter insist that inflation must be fought by producing a budget that would be balanced if there were only a mild recession--even though the deep recession now under way is just about certain to bring another large deficit.

The most likely recession-fighting strategy is a tax cut. Carter and aides have been telling Congress that they will not even discuss one until the legislators produce a fiscal 1981 budget that is theoretically balanced. But the President has left himself an out. He has said that he will not allow a cut this year, leaving the possibility that he might advocate one that would be enacted this year but not take effect until 1981. Says Charles Schultze, Carter's chief economic adviser: "Obviously, we are going to have a tax cut. The real question is when."

Economists, businessmen and many politicians nonetheless are taking a 1981 tax cut for granted, and are speculating on its size. Guesses are settling in around $25 billion to $30 billion, divided into the traditional split of two-thirds going to individuals and one-third to businesses, though Schultze for one would prefer increasing business's share in order to prompt job-stimulating investment. In Washington, there is some speculation that the President will not even wait until fall to propose a cut, but will spring it on Congress within the next month--before the Republican convention meets in Detroit July 14.

Ronald Reagan, Carter's certain Republican opponent, has been talking up a 30% slash in income tax rates phased in over three years, which the White House views as inflationary. Thus the stage is set for a weird role reversal: the Republican candidate assailing a Democratic President for fighting inflation by inducing unemployment; the President countering by accusing the Republican of proposing inflation to combat recession.

Other possible proposals to fight the recession--a big increase in federal spending on public-works programs, for example--incur an even more serious risk of spurring inflation. The biggest danger, therefore, is that the U.S. has got itself into a truly vicious circle: inflation is cured by recession, which is cured by more inflation, which results in another recession--and so on and so on.

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